The global financial crisis of 2008 prompted a regulatory response that has spawned a multiplicity of new acronyms, terminology and jargon that sometimes sounds like an altogether different language. 

And while much of this regulation has focused on the banking sector, every other area of the financial services industry – including asset management – has been affected.

The Alternative Investment Fund Managers Directive (AIFMD) is one crucial reform with which the fund management sector must get to grips.

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Here are five things everyone should know:

1. AIFMD is a European Union law

AIFMD is a piece of regulation passed into law in 2011 across the European Union as part of a package of measures to regulate financial services after the global financial crisis in 2008 – the EU’s member states subsequently took several years to implement the directive in their own countries. The directive sought to regulate the alternative investment industry for the first time in the EU, with all alternative investment managers covered by the regulation required to obtain authorization in order to operate.

 

2. AIFMD focuses on unregulated funds

The regulation covers previously unregulated funds such as hedge funds and private equity, as opposed to collective investment vehicles that have long been recognized, including most funds sold to retail investors.

Crucially, however, AIFMD targets the fund managers responsible for these funds, rather than the funds themselves; it applies to any fund manager that manages one or more unregulated fund in the EU, whether or not the manager itself is based in the EU.

These managers must now make a number of disclosures about each of their funds, including providing detail about the level of leverage, or borrowing. Such reports must be filed within 30 days of the end of the fund’s reporting period.

 

3. Value at Risk is a crucial yardstick

An important element of the AIFMD regulation is its attempt to quantify the risk being taken by individual funds.

Fund managers’ disclosures about their funds’ value at risk (VaR) provide regulators and investors with vital data about the potential exposures of the funds. VaR is an estimate of how much a set of investments might lose, under normal market conditions, over a particular time period.

For example, a fund might have a one-day 5% VaR of £1m – this would mean that on a given day, there is a 5% chance of the fund dropping in value by £1m or more. The calculation is usually undertaken on the basis that the fund does no trading during the period in question – and does not necessarily take gearing or leverage into account.

 

4. Leverage matters too, so you need the commitment approach

In addition to market risk, the AIFMD regulation requires fund managers to quantify the amount of leverage their funds have, whether through direct borrowing or via financial instruments such as derivatives, and to keep this leverage within set boundaries. One important consideration here is the fund’s exposure to risk calculated via the “commitment approach” – calculated in this way, leverage cannot exceed 100% of the fund’s net asset value. There are a number of complicated rules that set out how different forms of leverage within the fund’s portfolio should be translated into equivalent amounts of the underlying assets.

 

5. Compliance with AIFMD requires new capability around performance and risk measurement

Fund managers have no choice but to comply with the regulation that applies to them – whether it is AIFMD or reforms such as the UCITS IV directive. The increasing complexity of the disclosures required for compliance requires fund managers to have portfolio analytics and reporting systems that are capable of carrying out the calculations quickly and accurately, with as little manual intervention as possible.

Look for a system that delivers all of the functionality you need, plus the ability to share risk information throughout the business – and with regulators where required.
 

 

Takeaways

• AIFMD covers all asset managers marketing alternative funds in the EU
• Under AIFMD managers of alternative funds must be authorised and regulated
• Complying with AIFMD requires managers to understand and apply portfolio analysis techniques such as value at risk
• Asset managers need robust technologies and systems to ensure they can comply with evolving regulation

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